As financial planners, we talk about retirement risk a lot. We know that the word ‘risk’ might sound daunting and have negative connotations to those who are about to leave work behind. But, the best defence against risk is to understand it and know how to minimise it as much as possible.
During the early years of retirement, there are three key types of risk; investment risk, pension scam risk, and overspending risk. It can seem a daunting task to assess how at risk you are and then take the necessary steps to reduce the chance of it happening, but it’s a process that should be considered crucial. Armed with the right information, you can take steps to protect your pensions and enjoy your years after work.
1. Investment risk
Before the introduction of Pension Freedoms in 2015, more people chose to turn their pension into an income by using an annuity, rather than taking a drawdown. However, following the introduction of the new rule, the popularity of annuities has fallen, and more people than ever are withdrawing money from their pension under flexi-access drawdown.
Those people who would have previously brought an annuity but are now using flexi-access drawdown have a new risk to consider: investment risk.
For people using flexi-access drawdown, whose pension fund remains invested, ensuring it’s invested in line with their attitude to risk and income they need to generate is important. The
Retirement Outcomes Review from the Financial Conduct Authority (FCA) indicates this isn’t always the case, with some retirees not taking enough risk, limiting the growth potential of their savings.
The report states: “As pots become bigger, those who do not engage effectively could lose out on income in retirement, through poor investment choices or paying higher fees and charges.”
One example of this is the fact that 33% of people that went into drawdown but didn’t take financial advice are holding the money in cash accounts, a move that isn’t suitable for every situation.
The review continued: “Holding funds in cash may be suited to consumers planning to drawdown their entire pot over a short period. But it is unlikely to be suited to someone planning to drawdown their pot over a longer period. We estimate that over half of these consumers are likely to be losing out on income in retirement by holding cash.
“Someone who wants to drawdown their pot over a 20-year period could increase their expected annual income by 37% by investing in a mix of asset classes rather than just cash.”
Speaking with a financial planner can help you understand what investment risks your pension could face, balancing this up with your income goals.
2. Pension scam risk
91% of people are affected by cold calls; a common tactic used by fraudsters, according to research from Aegon. What’s more, 28% of people have been offered a ‘free pension review’, either by phone, email, or text; a term that the Financial Conduct Authority (FCA) has identified as being used during scams.
On average, each pension scam victim loses £91,000. It’s a significant sum for those entering their retirement years that could mean the difference between a comfortable standard of living and struggling to balance the books or even having to remain in work longer.
While we’ve all heard of pension scams, it’s easy to be sucked into the tales that criminals spin. According to the FCA, one of the most common tactics used by fraudsters targeting pension savings is to offer a ‘free pension review’. Whether the scammers then claim to be able to unlock your pension early or offer higher than expected and guaranteed returns, it can be a tempting proposal to seize.
When mitigating the risk there are three key things to keep in mind; do your research, be vigilant against unsolicited contact, and remember that if it sounds too good to be true, it probably is.
3. Overspending risk
With life expectancy and the cost of care both increasing, managing your retirement savings to cover the whole of your life is another concern.
Deciding on the level of income you need to take from your pension fund or any lump sums that you withdraw can be difficult; especially when you have no certainty over life expectancy or how your income needs will change in the future. The temptation to withdraw high levels to spend in the early, often active, years of retirement can understandably be luring. But it needs to be balanced with requirement in future years.
Research from Prudential shows it’s a common concern. Three years after the Pension Freedoms were introduced, 42% of over-55s state they are concerned about running out of money, while 41% worry about paying for long-term care. The pension changes placed more responsibility on the consumer, allowing you to use your pension fund in a way that suits your life goals, but this is balanced with additional risk.
Working with a financial planner will help you understand how much you can comfortably afford to withdraw from your pension to create a sustainable income in the short, medium and long term. By using forecasting models that take life expectancy and your plans for legacy wealth into consideration, you’ll be able to see realistically how much you have to spend.
If you’re planning for your retirement and want to understand how to mitigate the potential risks you could be affected by, give us a call today to arrange an opportunity to speak with a financial planner.
